Averaging down is a skill. Done well it can be your greatest asset. Done poorly it can mean disaster.
When asking questions of management, there are certain principles - do's and don't, that if they are followed, lead to much better information gathering. I would like to share these interview techniques in this post.
In the last blog post, Talking To Management, Ian argued for the importance of talking with management of microcap companies. Over my 15 years of investing in microcaps, talking with dozens of CEOs and CFOs, I have discovered that there is an art to interviewing management. When asking questions of management, there are certain principles – do’s and don’t’s – that, if they are followed, lead to much better information gathering. I would like to share these interview techniques in this post.
I am an advocate of taking the best ideas from one discipline, and applying that knowledge to other disciplines. With that in mind, the interview techniques I use when talking to public company executives are largely influenced by knowledge I have gained from outside of the investment world. Firstly, my health care training has strongly influenced my approach to interviewing management. Some of the most vital information during a patient consultation comes out during the patient history, or interview. The questions that are asked of the patient, and the way they are asked gives you the information to narrow down your possible diagnosis, and it will guide you on what tests you should perform to come to a definitive diagnosis. If you ask good questions, you are much more likely to arrive at the right diagnosis. An investor should have the same focus on asking pertinent questions of management, in a way that yields good answers that helps build a true picture of a company’s potential as an investment.
I have also been heavily influenced by studying the techniques and principles of interviewing developed by a former investigative reporter named John Sawatzky. Sawatzky has dedicated his life to studying the art of interviewing. He has spent years meticulously analyzing what makes for a good question. He has consulted with some of the largest media organizations in the world to teach his interview techniques, and for the last ten years, he has worked for ESPN where he trains the in-studio and on-field reporting staff on how to conduct better interviews.
With that, here are ten do’s and don’t’s that i have used over the years when interviewing management.
Things to do:
1) Build rapport with management. During your research, before you talk to management, try to find something in common with them. It may be something as simple as a link to the city they are headquartered in – maybe you lived there previously. Have a look at their LinkedIn summary. Maybe you know someone who worked with them in the past. Maybe you share the same alma mater. Mention it to them at the beginning of your initial conversation. A connection, however small can help you to build rapport early on and get them to open up to you. It could be something as simple as joking around with them, as Ian suggested, which might help them to lighten up and drop their guard. Once you build rapport with a CEO, they are much more likely to give you better quality information.
2) Ask open-ended questions. Open-ended questions are questions that can’t be answered with a yes or no answer. An open-ended question often involves the words what, how or why, and to a lesser extent who, when and where. These types of questions that encourage a subject to describe or explain have a better chance of giving you a complete response.
A close-ended question yields a yes or no answer. Close-ended questions are fine if you are trying to verify core information, but they do not give detailed answers. An example of a close-ended question would be “do you still think you can improve your gross margin to 50%?”. On the other hand, an open-ended question would be “what specific steps do you plan to take to improve your gross margin to 50%?” It is a subtle difference, but the open ended question will probably yield much deeper information compared to the close-ended question.
3) Questions should be lean. Keep each question short, and focused on a single subject. Some management teams have had media training, and have learned how to tactfully avoid answering your questions, and divert the discussion to their own agenda instead. Questions that are unfocused and cover a broad subject matter allows them too much range to do this. The more focused your questions are, the more meaningful the answers you will get back.
4) Questions should be neutral. Neutral questions are free of values or opinions of the investor. Avoid using charged words and try to keep your opinion out of your questions as that can distract management. When values or opinions are added by the interviewer, either positive or negative, it may bias the executive into answering your question how you want it answered. In the very worst cases, the subject closes up because they feel they have been criticized, and it may be difficult to get them to open up again. For example, a microcap company i have a holding in recently granted a large amount of stock options to management. I could have asked the CEO “a lot of shareholders are pissed off about this option grant, how do you defend it?”. Instead, I asked “what criteria did your board use in rewarding management in the recent stock option plan?” Instead of using charged words in my question, and him getting defensive, i got a very thoughtful answer that made sense once it was looked at from his standpoint.
5) Listen to answers and build new questions from there. Don’t be in too much of a rush to get to your next question on your list. By listening and asking them to elaborate, you will help management to articulate the subject matter. Also, by doing this, you are showing that you are listening, and it builds trust and credibility, which will allow management to open up deeper. When I first started interviewing public company management, i would stick very close to my question list, because i didn’t want to sound like an idiot ad-libbing off script. However, as my interview technique has improved over the years, I have noticed that a lot of the best information comes from going off script and asking for elaboration of an answer. As you gain experience interviewing management, don’t abandon the possibility of deeper information by jumping too quickly to your next question. Instead, pick up on a comment and follow-up.
6) Use acknowledging words that show you are listening. When management are answering your questions, use words like mmhmmm, i understand, and go on. This builds trust and rapport, and encourages them to open up further.
7) Use the uncomfortable silent pause to your benefit. When I first started interviewing management, they would be finishing up their answer to one of my questions, and I would be starting to look for the next one on my list. I sometimes would pause for a brief period until I could find my next question. A funny thing happened. Some of them continued to talk when there was a few seconds of silence. Humans hate lulls in conversations, and it makes a lot of people uncomfortable. So they feel the need to fill the void with something better. Sometimes those extra little nuggets of information contain some gems You have to use this technique sparingly, but i have found it can be a very effective technique for getting management to open up.
Things to avoid:
1) Don’t ask questions with multiple parts to them. Ask one question at a time. When long, multi-part, convoluted questions are asked, they may end up leaving management confused about what information you are looking for. Or it may give the executive the option to answer either one question or the other. If they are good at diverting questions, they may answer neither of your questions and will go off on their own carefully rehearsed message track and by the time they are done with their answer you will have forgotten your original questions. I see this all the time during conference calls when analysts ask long questions with multiple parts to them. I don’t know if it’s because they fear that they will only get to ask one question on the call, but by the time the executive is done answering he has often picked which part of the question he wants to answer and left it at that.
2) Don’t ask leading questions. When you convey your expectations to management by way of a leading question, it limits the possible answers, and their answer may not reflect the truth. I have seen this happen on conference calls, when investors are trying to tease guidance out of a CEO who is reluctant to provide it. The question will often go something like “I am using a 50% gross margin in my model for next quarter. Is that a reasonable expectation?”. Management will often reluctantly confirm that it is reasonable, because they have been influenced by the leading question. If they were willing to answer the direct question “what will gross margins look like next quarter?”, I am sure it would be a different number than the investor suggested most of the time. The investor is worse off than before he asked the leading question because he then plugs this faulty information into his earnings model.
Another example of a leading question asked on conference calls is when an analyst or investor’s question starts off with “you probably can’t answer this, but”, and then they go on to ask their question. You’ve just given management an out to not answer your question, if they are at all hesitant. Nine times out of ten, management will say something like “we can’t answer that because we haven’t given out that information to the market for competitive reasons”, or something along those lines. Whereas if they had just asked the question without adding “you probably can’t answer this, but”, management might answer the question 50% of the time.
3) Don’t interrupt them. You are trying to get information out of management, so let them talk after you ask them a question. We like the sound of our own voices, and we want to demonstrate that we are knowledgable about the subject being discussed, so we interrupt. Let management finish talking. You’ll get more complete answers to your questions.
The next time you listen to a conference call, or even a reporter interviewing someone on t.v., listen to the types of questions they ask. You will notice a pattern that good quality questions result in good quality answers.
I am certainly not a perfect interviewer of management. But over time, and with practice, i think my interviewing skills have improved dramatically. By following these interviewing techniques, and asking better quality questions, the answers you get back from management should help you make better decisions on whether to make a stock 20% of your portfolio or to sell every last share that you own.
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Averaging down is a skill. Done well it can be your greatest asset. Done poorly it can mean disaster.
Nicolai Tangen is the CEO of Norges Bank Investment Management, Norway's $1.4 trillion sovereign wealth fund.
Dilution is the subtle erosion of ownership. This hidden, persistent addition of new supply of shares leaves shareholders with less and less of the company’s value. Dilution, like inflation, is a silent killer of returns.